Tech Reports

ULCS-08-013

Abstract

In this thesis I present a framework for intelligent software agents to manage risk in electronic
marketplaces using Option Derivatives. To compare the performance of agents that
trade Option Derivatives with agents not using them, I create a simulation of a financial
marketplace in which software agents are vested with decision rules for buying and selling
assets and Options. The motivation of my work is the need of risk management mechanisms
for those Multi–Agent Systems where resources are allocated according to a market
mechanism. Autonomous agents participating in such markets need to consider the risks to
which they are exposed when trading in them, and to take actions to manage those risks.
This thesis considers the hypothesis that software agents can benefit from trading Option
Derivatives, using them as a tool to manage their exposure to uncertainty in the market.

The main contributions of this thesis are: First, an abstract framework of an Option
trading market is developed. This framework serves as a foundation for the implementation
of computational Option trading mechanisms in systems using Market–Based resource
allocation. The framework can be incorporated into existing Market–Based systems using
the traded resources as the underlying assets for the Option market. Within the framework,
four basic Option trading strategies are introduced, some of which reason about the risks
exposed by their actions. These strategies are provided as a foundation for the development
of more complex strategies that maximise the utility of the trading agents by the use
of Options. The second contribution of this thesis is the analysis of the results from simulation
experiments performed with the implementation of a software Multi–Agent System
based on the developed Option trading framework. The system was developed in Java using
the Repast simulation platform. The experiments were used to test the performance of the
developed trading strategies.

This research shows that agents which traded Options by choosing actions aiming to
minimize their risk performed significantly better than agents using other trading strategies,
in the majority of the experiments. Agents using this risk–minimizing strategy also
observed a lower correlation between the asset price and their returns, for the majority of
the experimented scenarios. Agents which traded Options aiming to maximize their returns
performed better than their peers in the scenarios where the asset price volatility was high.
Finally, it was also observed that the performance differential of the strategies increased as
the uncertainty about the future price of the asset was increased.

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